Price discrimination is the practice of selling identical goods or services at different prices from the same provider.

In pure price discrimination, the seller will charge the buyer the absolute maximum price that he is willing to pay.

The goal of price discrimination is for the seller to make the most profit possible.

Although the cost of producing the products is the same, the seller has the ability to increase the price based on location, consumer financial status, product demand, etc.

An example of price discrimination would be the cost of movie tickets.

Prices at one theater are different for children, adults, and seniors.

The prices of each ticket can also vary based on the day and chosen show time.

Ticket prices also vary depending on the portion of the country as well.

Industries use price discrimination as a way to increase revenue.

It is possible for some industries to offer retailers different prices based solely on the volume of products purchased.

Price discrimination can also be based on age, location, desire for the product, and customer wage.

What is price discrimination?

The most basic definition of price discrimination is the act of charging different prices for identical items.

Price discrimination is when a seller can charge different customers that are basically identical different prices in an attempt to extract as much profit as possible.

Business firms operating in competitive markets are not restricted to charging only one price for their product.

These firms may find that charging different customers different prices for a common product may actually increase the profits of the firm.

This charging of different prices for a particular good is known as Price Discrimination and is very common in various markets around the globe.

Price Discrimination Criteria

Within commerce, there are specific criteria that must be met in order for price discrimination to occur:

  • The firm must have market power.
  • The firm must be able to recognize differences in demand.
  • The firm must have the ability to prevent arbitration or resale of the product.

Types of Price Discrimination

Price discrimination is categorized into three types:

  1. First degree price discrimination: charging whatever the market will bear
  2. Second degree price discrimination: quantity discounts
  3. Third degree price discrimination: separate markets and customer groups

These three types all involve additional effort on the part of the firm to determine the preferences of different customers and their willingness to pay.

These efforts are justified by a greater level of profits relative to that which can be earned by charging a single price.

First Degree

This assumes that a seller knows the maximum price that every consumer is willing to pay.

In theory, this allows the seller to maximize profit with no deadweight loss since it creates a perfectly efficient market (in economic terms), although in practice this is difficult to observe.

Second Degree

Price varies depending on the quantity in demand.

A common example of this is bulk discounts. Buyers differentiate themselves based on their preferences.

To broaden the definition, it can also apply to quality. For example, first-class and economy airline tickets, but the common factor is that the consumers differentiate and group themselves.

Third Degree

Involves selling the same product at different prices to buyer segments.

This happens when a company cuts the market into segments (segmentation variables) and fixes different prices for each group.

Price is varied between segments – the assumption being that these attributes factor into a customer’s willingness to way.

The main segmentation variables are geographic, demographic, psychographic, and behavioral (seniors, students, the price per country, etc).

Examples of Price Discrimination

Price discrimination is a driving force in commerce.

It is evident throughout markets and generates the highest revenue possible by shifting the price of a product based on the consumer’s willingness to pay, quantity demanded, and consumer attributes.

Many examples of price discrimination are present throughout commerce including:

Airline Industry

The airline industry uses price discrimination regularly when they sell travel tickets simultaneously to different market segments.

Price discrimination is evident within individual airlines, but also in the industry as a whole.

Tickets vary based on the location within the plane, the time and day of the flight, the time of year, and what city the aircraft is traveling to.

Prices can vary greatly within an airline and also among airlines.

Customers must search for the best-priced ticket based on their needs.

Airlines do offer other forms of price discrimination including discounts, vouchers, and member perks for individuals with membership cards.

Pharmaceutical Industry

The pharmaceutical industry experiences international price discrimination.

Drug manufacturers charge more for drugs in wealthier countries than in poor ones.

For example, the United States has the highest drug prices in the world.

On average, Europeans pay 56% less than Americans do for the same prescription medications.

However, in many countries with lower drug costs, the difference in price is absorbed into the taxes which results in lower average salaries when compared to those in the United States.

Academic Textbook Industry

Academic textbooks are another industry known for price discrimination.

Textbooks in the United States are more expensive than they are overseas.

Because most of the textbooks are published in the United States, it is obvious that transportation costs do not raise the price of the books.

In the United States price discrimination on textbooks is due to copyright protection laws.

Also, in the United States textbooks are mandatory whereas in other countries they are viewed as optional study aids.